I didn't think things could get much worse for insurance technology company Lemonade (LMND -0.61%) last year, but they've gotten much, much worse. Investors appear to have lost any confidence at all in this former market darling. But that seems curious to me, considering its popularity with customers and strong top-line growth.

Still, while there are plenty of reasons to doubt the company at the moment, the tide might be about to turn. Here's why.

Updating insurance for the digital age

Lemonade is the brainchild of a collaboration between technology veteran Dan Schreiber and serial entrepreneur Shai Winninger, who serve as co-chief executive officers of the company. The two created the business to offer modern, attractively priced, consumer-centric insurance services for a new generation of customers who they felt they could convince to actually love their insurance company. 

But the established insurers can also do this, you say? That's partially true, and of course that's what's been happening. Schreiber disputes that point by explaining that Lemonade was built on a digital substrate with an explicit approach that combines a customer-first orientation and machine learning. 

The model is working. Lemonade has racked up a customer count of more than 1.8 million in a few short years, and revenue as well as gross earned premium have been soaring along with that.

Lemonade revenue and gross earned premium.

Image source: Lemonade.

Why investors are so sour on Lemonade

So what's so bad, right? Insurers work a bit differently from other companies because they have to pay out when customers file claims. If it's paying out too much, it won't end up making any money, regardless of how much customers are paying in policy premiums. The work of an insurance company is to write policies precisely to make them attractive to customers while still accounting for disaster and claim coverage. It's a fine balance that the large companies have perfected through their decades of operation and data, and that Lemonade is still struggling to get right. That's resulted in high loss ratios, which is the measurement of how much an insurance company is paying out in claims as a percentage of the collected premiums.

Lemonade loss ratio.

Image source: Lemonade.

That's at least in part because it's a new company; management says that older cohorts' loss ratios are much lower, so this partially reflects a company that still is in launch mode. Lemonade rolled out a blitz of new products over the past two years and is still entering new markets, plus its strategy of recruiting young customers with a cheap plan and growing through cross sells and upsells means a sizable chunk of customers are either new or purchasing new policies. It's taking a while to stabilize the loss ratio, and investors are getting weary.

The other big issue is the enormous net loss. Net loss widened from $34 million in the 2021 fourth quarter to $64 million in the 2022 fourth quarter. That's not surprising considering the product and market rollouts, and specifically the acquisition of another insurer, Metromile. However, again, investors want to see progress here.

Why it might start getting sweeter

Management said losses would peak in the 2022 third quarter, and indeed, net loss did improve from the third to the fourth quarter. The company is done with its product launches for the time being, which should ease expenses, and as revenue increases that should lead to more improvement. Management also said that it would now shift its focus to improving the loss ratio.

Lemonade stock is trading at a price-to-sales ratio of less than 3, which is dirt cheap for such a high-growth stock, and for a stock that was trading at a price-to-sales ratio of around 100 only two years ago.

Lemonade reports 2023 first-quarter earnings this week. If it demonstrates improvement in the loss ratio and profitability, expect the stock to jump. If it can keep it up, there's lots of long-term upside.